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Linking Australian and European emissions trading schemes

Late last year, legislation was passed to make fundamental changes to the carbon price from 1 July 2015 (the time when it moves from being ‘fixed’ price to a ‘flexible’ price) to facilitate the linking of the Australian and the EU emissions trading schemes. Since then, EU and Australian bureaucrats have been progressing negotiations on the finer details of such arrangements with a view to finalising legislation by mid-2013.

This articles discusses the details of the proposed and implemented legislative changes concerning the EU-Australian emissions trading link and their implications for Australian companies.

Price implications: what this means for Australian businesses

The link is expected to provide Australian businesses with access to a larger market for cost-effective emissions reductions as well as provide more flexibility to businesses with operations in both Australia and Europe, thereby possibly reducing compliance costs.

When one looks at the details released in the recent legislative package, it does appear that, based upon current prices of international units, Australian liable entities will now likely be able to meet their compliance obligations at a cheaper rate than would otherwise be the case without the amendments.

Linking arrangements of the European Union and Australian ETS

The Clean Energy Amendment (International Emissions Trading and other Measures) Act 2012 confirms the Government announcement on 28 August 2012 that Australia and Europe will be linking their emissions trading systems, removing the carbon price floor under the Clean Energy Act 2011 and allowing Australian businesses to use European Union carbon credits to comply with their obligations.

To facilitate the linkage between the EU emissions trading scheme (EU ETS) and Australia’s emissions trading scheme, a number of changes have been made to the Australian carbon price mechanism which is set out in the Clean Energy Act2011 and its related legislation. The most significant changes are:

First stage (1 July 2015 – 1 July 2018): Changes which lay the foundations for unilateral linking allowing Australian entities to use European units to meet their domestic carbon liabilities.

Second Stage (1 July 2018 onwards): No changes made yet, but flexibility introduced to allow for later bi-lateral linking allowing Australian and European carbon units to be used interchangeably by liable entities in meeting their respective compliance obligations.

The removal of the $15 carbon price floor.

The removal of the ‘surrender charge’ on international units.

Removal of the price floor

Originally, under the Clean Energy Act2011, a minimum carbon price or price floor of $15 per tonne of CO2-e was put in place to avoid price plunges during the flexible price period (from 2015) which would otherwise undermine Australian investment in low polluting technologies, energy efficiency and renewable energy.

However, weakened demand as a result of the global economic downturn coupled with an over-supply of credits in the marketplace has resulted in the prices of European Union Allowances (EUAs) and Kyoto Units tumbling in recent times, with Certified Emissions Reductions (CERs) plunging to record lows of under €1 euro in past months.

The crisis in European and international carbon markets has made the Australian carbon price (a $23 fixed price for the first three years and a floor price of $15 during the flexible period from 1 July 2015) appear excessive by comparison. This had been a persistent criticism of the Australian carbon price mechanism from industry stakeholders and the Coalition.

In response to this criticism, the removal of the $15 price floor in the amending legislation means that carbon abatement is set to become much cheaper (based on current and forecast international prices) for Australian liable entities from 1 July 2015.

Changes to the thresholds and types of international carbon units

Under the Clean Energy Act 2011, from 1 July 2015 entities would be able to surrender up to 50 per cent of their carbon liability via international permits. As there was no link with the European scheme, this did not include EUAs.

Now that the EU ETS is set to be linked to Australia’s scheme, changes were also introduced to include EUAs. However, the amending legislation also introduced a sublimit of 12.5 per cent of liability (a reduction from 50 per cent in the original legislation) which can be satisfied by Kyoto Units such as CERs, Emissions Reduction Units (ERUs) and Removal Units (RMUs).

Provided the trend continues whereby EUAs attract a significant premium to Kyoto units, and assuming international units are cheaper than Australian units, we can expect that liable entities will surrender 12.5 per cent of their liability from Kyoto units and 37.5 per cent from EUAs.

The remainder of an entity’s liability will be made up of Australian Carbon Units (ACUs) issued by the Australian Government and Australian Carbon Credit Units (ACCUs) issued under the Carbon Farming Initiative offset-generating program.

Removal of the surrender charge on international units

Under the Clean Energy Act 2011, a ‘surrender charge’ (or fee) was to be imposed on liable entities surrendering international permits in satisfaction of their obligations under the scheme. This effectively increased the price of any international units to $15 (the floor price for Australian units) at the time of surrender.

This has now been removed, meaning that liable entities will not need to pay any additional charges on top of what they pay for international units at the time of purchase. The ability of liable entities to take advantage of current depressed prices for international units depends on the type of units. The details of the Registry linking (which will facilitate the purchase of ERUs) are yet to be finalised. The proposed changes are discussed below.

Details of the Registry link

On 24 January 2013, the European Commission recommended to the Council that formal negotiations be opened with Australia to link the EU ETS. These negotiations have culminated in a Consultation Paper on the ‘Registry options to facilitate linking of emissions trading systems’ which was jointly released on 6 March 2013 by the Australian Government and the European Commission (Joint Proposal).

Draft regulations to give effect to the changes to the Australian carbon registry have also been released for comment and the EU and Australian Governments have agreed to finalise the registry arrangements for the interim unilateral link by 1 July 2013 (with the regulations to be introduced by 1 June 2013). Submissions by stakeholders and interested parties are due by 28 March 2013.

Under the Joint Proposal, by 1 July 2015, the Australian Government will set up an account in the European Union Registry. This will enable Australian liable entities which do not have a Union Registry Account to purchase EUAs via this account. Australian-issued international units (AIIUs) will be issued in the Australian registry accounts of liable entities to ‘shadow’ the EUAs units (which won’t actually be held by liable entities).

Australian liable entities with a Union Registry account are already able to purchase EUAs and take advantage of current low prices in preparation for meeting their compliance obligations come 1 July 2015. However, for most Australian liable entities which do not have a Union Registry account, until the new inter-government registry link is established, the only way to take advantage of the current low prices is to enter into forward contracts or option agreements with holders of EUAs for the delivery of EUAs into the Australian Government Union Registry.

On the other hand, CERs are capable of being purchased by Australian liable entities (either from traders and brokers in Australia or through direct contracts with the foreign project owner/operator) without the need for a Union Registry account in Europe.

This is the first stage of the linking agreement – being a one-way unilateral link. From 1 July 2018 it is envisaged that (subject to a bilateral agreement being confirmed) two-way bilateral linking will be introduced whereby liable European entities will be able to acquire and surrender ACUs created by the Australian Government.

Risks and opportunities

Liable entities need to consider the real and perceived regulatory and financial risks along with potential financial benefits of involvement in the carbon market and taking advantage of the current EU carbon price crisis.

With the removal of the floor price and the removal of the surrender charge under the new amendments, a significant regulatory handbrake on investor confidence in respect of international carbon markets has also been lifted. In anticipation of 1 July 2015, companies are now able to take advantage of the current depressed prices for both Kyoto units and EUAs (in certain circumstances) without the spectre of having to top up the price at the time of surrender via any imposed ‘surrender charge’.

Notwithstanding these amendments many Australian companies are adopting a ‘wait-and-see’ approach. This is unsurprising given the spectre of repeal legislation being introduced by a Coalition Government, concern over the EU’s ability to legislate to intervene in its troubled carbon market and the absence of a functional inter-governmental Registry link.

Alternatively, a more active approach can be facilitated by appropriate contracting solutions such as futures, forward contracts and option agreements to take advantage of attractive carbon prices now whilst mitigating the regulatory risks associated with the September election, the threat of repeal and the uncertainties of the European Parliamentary process and the EU carbon market.

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